Edited version of your private ruling

Authorisation Number: 1012471302571

Ruling

Subject: capital gains tax implications for a deceased estate

Question 1

Upon the death of the life interest holder, will the sole remainderman entitled under the will, become absolutely entitled to the assets of the Estate, thereby triggering CGT event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes

Question 2

Upon CGT event E5 happening, will the sole remainderman make a capital gain?

Answer:

Yes

Question 3

Will the sole remainderman be entitled to disregard the capital gain made from CGT event E5 happening?

Answer:

Yes

Question 4

Will CGT event E7 happen when the legal titles of the assets of the Estate are transferred to the sole remainderman?

Answer:

No

Question 5

Will there be any CGT consequences when the legal titles of the assets of the Estate are transferred to the sole remainderman?

Answer:

No

Question 6

Will section 115-228 of the ITAA 1997 apply to treat the sole remainderman as 'specifically entitled' to the capital gain made by the Estate under CGT event E5?

Answer:

Yes

This ruling applies for the following period

Year ending 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· your application for private ruling

· copy of deceased's will

· copy of probate of deceased's will

· copy of life tenant's will

· copy of probate of life tenant's will

The Testator died over 20 years ago.

Probate of the will of the deceased was granted approximately 1 year after their death.

Pursuant to the will of the deceased, a life interest in the Estate was granted to their spouse (the life tenant), and the remainder interest in the Estate was held by their child (the remainderman).

The remainderman did not pay anything to acquire their interest in the trust estate.

The life tenant died.

Probate of the will of the life tenant was granted.

The life tenant's will provided that the residue of their estate was to pass to their child.

The assets of the Estate consist of a large share portfolio. All of the shares were acquired by the Estate after the death of the Testator and after 20 September 1985.

You state that the remainderman's absolute entitlement to the shares upon the death of the life tenant is record in the accounts or records of the trust.

As at the date of the application, none of the shares have been transferred by the Estate to the remainderman.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 112-20

Income Tax Assessment Act 1936 Subsection 95(1)

Income Tax Assessment Act 1997 Section 109-5

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 115-228

Income Tax Assessment Act 1997 Subsection 102-5(1)

Income Tax Assessment Act 1997 Section 974-160

Income Tax Assessment Act 1936 Division 6

Reasons for decision

Detailed reasoning

CGT event E5

Subsection 104-75(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee. The time of the event is when the beneficiary becomes absolutely entitled to the asset (subsection 104-75(2) of the ITAA 1997).

Taxation Ruling TR 2006/14 discusses the capital gains tax implications for life and remainder interests and it states, at paragraph 202 to 203, that:

Division 128 applies to the passing of an asset from a deceased individual's legal personal representative to a beneficiary in their estate (provided the asset was owned by the deceased individual at the time of their death).

Accordingly, 'a trust to which Division 128 applies' requires more than the identification of the trust as a deceased estate. The Commissioner considers that the words 'a trust to which Division 128 applies' should be interpreted as a deceased estate to the extent that it is a trust over an asset originally owned by a deceased individual and which may pass to the beneficiary in accordance with section 128-20 (that is, under the will, by intestacy and so on).

Therefore, the trust is not 'a trust to which Division 128 of the ITAA 1997 applies' as the assets of the trust (the shares) were not owned by the deceased individual at the time of their death, the shares were acquired by the deceased's estate after the deceased's death.

Taxation Ruling TR 2004/D25 discusses the concept of 'absolute entitlement' and states, at paragraph 10, that:

The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction.

Further, at paragraphs 21 and 22 of TR 2004/D25 it states;

A beneficiary has all the interests in a trust asset if no other beneficiary has an interest in the asset (even if the trust has other beneficiaries).

Such a beneficiary will be absolutely entitled to that asset as against the trustee for the purposes of the CGT provisions if the beneficiary can (ignoring any legal disability) terminate the trust in respect of that asset by directing the trustee to transfer the asset to them or to transfer it at their direction

As a sole beneficiary, in respect of an asset, has the totality of the beneficial interests in the asset, they automatically satisfy the requirement that their interest in the asset be vested in possession and indefeasible.

In your case, on the death of the life tenant, the sole remainderman (beneficiary) had a vested and indefeasible interest in the asset (the shares), accordingly, they became absolutely entitled, as against the trustee, to the asset as they could call for the asset to be transferred to them or to be transferred at their direction. Therefore CGT event E5 happened.

Consequences of CGT event E5

Subsection 104-75(3) of the ITAA 1997 provides that the trustee makes a capital gain from CGT event E5 if the market value of the asset (at the time of the event) is more than its cost base. The trustee makes a capital loss if the market value is less than the asset's reduced cost base. Subsection 104-75(4) of the ITAA 1997 explains that a capital gain or loss made by the trustee is disregarded if it acquired the asset before 20 September 1985.

Taxation Ruling TR 2006/14 states, at paragraph 48:

Any capital gain or loss from CGT event E5 happening to the trustee is taken into account in working out the trustee's net capital gain or loss. A net capital gain is included in the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 and taxed in accordance with Subdivision 115-C.

Subsection 104-75(5) of the ITAA 1997 explains that the beneficiary makes a capital gain from CGT event E5 if the market value of the asset (at the time of the event) is more than the cost base of the beneficiary's interest in the trust capital to the extent it relates to the asset. The beneficiary makes a capital loss if that market value is less than the reduced cost base of that beneficiary's interest in the trust capital to the extent it relates to the asset.

In this context, the cost base of the beneficiary's interest, if the beneficiary did not incur expenditure to acquire it, would be subject to the market value substitution rule in subsection 112-20(1) of the ITAA 1997. This would make the first element of the cost base of the interest its market value at the time the beneficiary becomes absolutely entitled to the asset constituted by the interest, as the beneficiary would not have any interest in the trust capital before becoming absolutely entitled to the trust asset.

Subsection 104-75(6) of the ITAA 1997 states that a capital gain or capital loss the beneficiary makes from CGT event E5 is disregarded if:

a) the beneficiary acquired the CGT asset that is the interest (except by way of an assignment from another entity) for no expenditure; or

b) the beneficiary acquired it before 20 September 1985; or

c) all or part of the capital gain or capital loss the trustee makes from the CGT event is disregarded under Subdivision 118-B (about main residence).

In your case, on the death of the life tenant, the life interest ended and the remainderman became absolutely entitled to the assets of the trust as they were the sole beneficiary.

Accordingly, CGT event E5 happened. The date of the event is when the beneficiary became absolutely entitled to the assets, that is, on the death of the life tenant.

As the assets (the shares) were not acquired by the trustees prior to 20 September 1985, the trustees can not disregard any capital gain or loss made from the event.

However, as the beneficiary (the remainderman) will acquire the CGT assets (the shares) for no expenditure, they will be able to disregard any capital gain or loss made from the event by virtue of subsection 104-75(6) of the ITAA 1997.

CGT event E7

Subsection 104-85(1) of the ITAA 1997 provides that CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital. The time of the event is when the disposal occurs (subsection 104-85(2) of the ITAA 1997).

Subsection 102-25(1) of the ITAA 1997 states: work out if a CGT event (except CGT events D1 and H2) happens to your situation. If more than one event can happen, the one you use is the one that is the most specific to your situation.

In general, CGT event E5 happens when a beneficiary becomes absolutely entitled to an asset of the trust as against the trustee, which usually occurs in those situations where there is a sole beneficiary of the trust. In contrast, CGT event E7 is more likely to happen when the trustee of the trust disposes of a CGT asset/s of the trust to satisfy a beneficiary's capital interest, which in most cases occurs in situations where there are multiple beneficiaries who have an interest in the capital of the trust. This is because a beneficiary of a trust will generally have difficulty in establishing that they have absolute entitlement to an asset as against the trustee if one or more other beneficiaries of the trust also has an interest.

Accordingly, as the remainderman is the sole remaining beneficiary of the trust, CGT event E5 is the most specific CGT event for this situation.

Consequences on transfer of legal title of shares to the remainderman

Section 109-5 of the ITAA 1997 discusses the general acquisition rules for CGT assets and provides that, for CGT event E5, the beneficiary of a trust who becomes absolutely entitled to a CGT asset of the trust as against the trustee, will acquire the asset at the time they become absolutely entitled.

Section 106-50 of the ITAA 1997 explains that if you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this Part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

Therefore, as the remainderman became absolutely entitled to the assets of the trust on the death of the life tenant, an act done by the trustee after this date to transfer the legal title of the asset to the remainderman will be considered an act done by the beneficiary (the remainderman).

Accordingly, no CGT event will happen when the legal title in the asset is transferred to the beneficiary as the beneficiary (remainderman) is already considered to be the 'owner' of the asset.

Is the Remainderman 'specifically entitled' to the capital gain made by the trust under CGT event E5?

The capital gains tax streaming provisions in Subdivision 115-C of the ITAA 1997 ensure, among other things, that a beneficiary of a trust who is made 'specifically entitled' to a capital gain made by the trustee (a 'trust capital gain') will be assessed on it (rather than the gain being assessed proportionately to the beneficiaries entitled to trust income).

If a trust estate makes a capital gain, section 115-228 of the ITAA 1997 sets out the amount (if any) of that gain to which a beneficiary of the trust is treated as being 'specifically entitled'.

Subsection 115-228(1) of the ITAA 1997 provides that the amount of a capital gain that a beneficiary is 'specifically entitled' to is calculated according to the following formula:

Capital gain × Share of net financial benefit
   Net financial benefit  

where:

'net financial benefit' means an amount equal to the financial benefit that is referable to the capital gain (after any application by the trustee of losses, to the extent that the application is consistent with the application of capital losses against the capital gain in accordance with the method statement in subsection 102-5(1)).

'share of net financial benefit means an amount equal to the financial benefit that, in accordance with the terms of the trust:

(a) the beneficiary has received, or can be reasonably expected to receive; and

(b) is referable to the capital gain (after application by the trustee of any losses, to the extent that the application is consistent with the application of capital losses against the capital gain in accordance with the method statement in subsection 102-5(1)); and

(c) is recorded, in its character as referable to the capital gain, in the accounts or records of the trust no later than 2 months after the end of the income year.

'Financial benefit' is defined to mean anything of economic value, including property and services (section 974-160 of the ITAA 1997). It includes a receipt of cash or property, an increase in the value of units in a unit trust, the forgiveness of a debt obligation of the trust or, any other accretion of value to the trust.

ATO Interpretative Decision ATOID 2013/33 discusses the 'specifically entitled' concept on the happening of CGT event E5. ATOID 2013/33 confirms that the financial benefit referable to a capital gain made by the trust on CGT event E5 is the asset itself (or the value of that asset) and the absolutely entitled beneficiary (the sole remainderman) is, in accordance with the terms of the trust created by the will, the only one that is expected to receive the asset (and thus that benefit).

Further, ATOID 2013/33 explains that a will which creates the trust meets the description of a record of the trust in which is recorded the financial benefit that the remainderman is expected to receive in its character as a benefit referable to the capital gain - the will records the remainderman's absolute entitlement to the asset.

ATOID 2013/33 then states that it follows that the absolutely entitled beneficiary will be regarded as specifically entitled to the capital gain that arose from CGT event E5.

In your case, CGT event E5 happened when the remainderman became absolutely entitled to the assets of the trust on the death of the life tenant. The trustee made a capital gain from the event as the market value of the asset (the shares), at the time of the event, was more than its cost base.

The remainderman will receive the entire 'financial benefit' of any capital gain made on the happening of the event as they are the sole remainderman of the estate and, under the terms of the deceased's will, they are entitled to all the income and capital of the trust on the death of the life tenant. Further, the remainderman's share of the net financial benefit (being their absolute entitlement to the shares on the death of the life tenant) is recorded in the will of the deceased.

Accordingly, the conditions necessary to treat a beneficiary of the trust as being 'specifically entitled' to a gain made by the trust have been satisfied.